The Reserve Bank of Australia (RBA) this week increased the cash rate by 0.5 per cent to 0.85 per cent. The market is expecting more rate rises this year and with this forecast, demand for housing has decreased. If there is a significant housing decline, this will affect some sections on the market. Below are a list of stocks to avoid in a housing correction.

Consumer discretionary

Consumer discretionary stocks in furniture and appliances will be the most affected by a housing downturn. When house prices were increasing and sentiment towards housing was positive, consumers flocked to retailers to furnish their new homes with new furniture and appliances. People are not buying homes at the same rate and hence not visiting these stores anymore. Stocks such as Harvey Norman (ASX:HVN) will be affected. Consumers would also buy less electronics and white goods. This would therefore affect JB Hi-Fi (ASX:JBH).

Clothing retailers will also feel the pinch with the housing downturn. When housing prices are rising, consumers are positive about their financial situation. They therefore feel confident to spend. They may redraw equity from their homes in a rising real estate market and spend it on goods. When the housing market decreases, consumers feel pessimistic about their financial position. This causes them to become careful with their spending. The housing downturn will only cause more consumers to be frugal with their spending.

Banks

Major housing price declines have caused high loan default rates. Australian banks would be vulnerable if housing turns down sharply. The big four banks derive 40-60 percent of their earnings from home loans.  A substantial correction may occur if there is a large rise in unemployment and interest rates are hiked rapidly. Some borrowers may feel pressure if these scenarios occurred, resulting in large number of defaults. Household debt to income ratio in the country is at an all time high of 190 per cent.

Real Estate Investment Trusts (REITs)

The slowing housing market may put pressure on REITs. These are trusts which invest in residential and commercial properties. REITs are affected by the weakness in real estate prices. It is therefore important to understand which REITs are exposed to residential housing, and which ones are exposed to other sectors of the property market.

Property developers

Property developer stocks will take a hit if there is housing decline as developers will have a difficult time selling properties if demand decreases.  Banks also tightened their lending standards when rate rises occur reducing the amount banks are willing to lend to consumers.

Lauren Hua is a private client adviser at Fairmont Equities.

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